In September 2011, we authored a piece addressing the movement in the price of gold. At the time, the world was coming out of the great financial crisis, and the interest in gold had reached a high point. We argued for caution based upon our belief that the creation of gold exchange traded funds (ETFs) had provided investors with a low cost, easy way to allocate some monies to gold.
The initial market response was positive, and the gold ETFs grew significantly in size from their start in 2004 through 2011. As the ETFs grew, they moved gold from the marketplace of jewelry and some industrial uses to shelves in warehouses owned or leased by the ETFs. The result of this increased demand was an increase in price, and there was also a supply response as citizens brought gold pieces to gold brokers who paid cash for the gold. The subsequent mining response was more muted since adding gold mining capacity is quite expensive. To illustrate this increase in price, the Spider Gold ETF (ticker: GLD) moved from $41.84 a share on January 3, 2005, to $184.82 on August 22, 2011. It was $86.23 on 12/29/2008 – It was definitely the asset to own during the crisis.
Once the crisis ended, however, owners of the ETFs started to realize that their initial allocation to gold (2- 5%) was now upwards of 10%. This, in part, motivated selling. The result was additional supply to the market and, without an offsetting increase in demand, a subsequent decline in prices. GLD bottomed in November of 2015 at approximately $103. Recently, it moved above the $184 mark, taking nearly 10 years to recover from the selling.
Bitcoin, a decentralized digital currency, can be viewed as a modern-day alternative to gold. While not exactly the same story, much can be learned about Bitcoin from the history of the price action of gold. Bitcoin has some inherent attractiveness tied to its structure and its limits on production. Worries about Sovereign debt coupled with the ability of governments to print money—thereby creating inflation—makes Bitcoin, with its limited supply, appear to offer an attractive alternative. However, unlike traditional currency or even gold, Bitcoin has no use other than what someone is willing to give you for it.
Bitcoin just now is starting to see ETF ownership, as some investment advisors are being asked to purchase it by their clients. As the “institutional” acceptance grows, via ETFs and other investment options, we expect the price to continue to rise.
The real risk occurs when the buying slows, and several questions come to mind. Will producers of actual products accept Bitcoin for payment? Will you be able to buy a pack of gum with Bitcoin? Even if ownership of Bitcoin broadens, due to the creation of Bitcoin ETFs, if it does not become a currency that can purchase goods, we believe it will not be long lived. We believe Bitcoin will continue to generate interest as long as it goes up in value. Our worry is what happens when it starts to go down?
Bitcoin bulls argue that the advent of institutional ownership gives credence and support to the currency. The ability to move Bitcoin with less friction (cost) than other currencies does have some attractiveness. However, without some “state sponsorship,” its value is purely driven by supply and demand. It is truly “currency like” in that it generates no cash flow and hence there is no way to value it as an investment. The value is a function of limited, well defined supply compared to undefined demand.
One final aspect of Bitcoin that gets overlooked is the issue of its limited supply. Bitcoin, by design, is limited to 21 million units, and to date approximately 19 million have been mined. As demand for Bitcoin has grown there has been some ability to increase production. Now, as it becomes harder to grow supply, demand changes will directly flow to prices. On the one hand, this is good for the price as the increase in demand drives the price higher. Eventually, however, Bitcoin will price itself out of the market. Of course, since it is digital, it can be broken into pieces (bits). This then increases the supply—even though the “mined supply” is limited, the fractional supply is unlimited. The question then becomes—is supply truly limited and how will the price ultimately be set?
We believe that trying to determine the level of demand for Bitcoin at any moment is virtually impossible. Therefore, it is possible that it will continue to go up or it may go down. If we purchase it today, we would worry about who would want it tomorrow and why? While the price movements in Bitcoin may offer holders excitement while it appreciates, until we can see that it is useful in some other way than it simply can go up in value, we prefer not to take the chance on it. Rather, we want to put our funds in investments that can provide cash flow and over time can return cash to us that then be used to purchase tangible goods and services.
Bitcoin is one of many cryptocurrencies and is not a physical asset. Rather, it is a decentralized digital currency. According to research firm Flipside Crypto, about 2% of anonymous ownership accounts control about 95% of the bitcoin supply. (Bloomberg, “Bitcoin Whales’ Ownership Concentration Is Rising During Rally,” 11/18/2020)